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It’s real, it’s global, it can’t be stopped and it can be good or bad.
It is inflation.
I had someone tell me recently that U.S. annual inflation has been 10% for the last several years. That is not true of course although it may feel like it to some people.
My guaranteed income is a pension and Social Security. There is no COLA on my pension. Since I retired in 2010, the buying power on the great majority of my income has eroded by 43%. Most Americans are similarly affected or worse.
Not a day goes by I don’t read about inflation in my retirement Facebook groups or hear from a fellow retiree complaining about the size of the next expected Social Security COLA. “Absurd” at 2.5 % one women told me. “They fudge the numbers,” another retiree said.
A few of my fellow retirees still hold out the hope our former employer will give a COLA – it never will. I arranged for seven ad hoc COLAs over my years in employee benefits, but that was before there was a 401k plan with employer match in addition to the pension. To this day I don’t think most of my fellow retirees see the connection – in effect a COLA was paid by the company in advance.
I recall decades ago in seminars telling employees planning to retire that longevity was their greatest risk in retirement. Well, this is what – in part – that looks like – the impact of compounding inflation.
It must be worse for those who retired early in their fifties.
The history of inflation is no secret, it goes up and down, extreme highs and lows, but it always keeps chugging along. It’s like reverse investment compounding.
Nevertheless, when it comes to retirement, it seems largely to be ignored and we feign surprise when our buying power ain’t what it used to be.
Use any retirement planning tool and you are asked for an inflation assumption, but how many Americans take the trouble or if they do, use realistic assumptions? I didn’t, I used a different approach I dare not mention again, but even my strategy hasn’t been totally sufficient and I’m glad I have a backup when needed in the form of interest and dividend investment income.
The 4% withdrawal strategy includes a inflation adjustment and SS has a COLA as do most public employee pensions, but that leaves a lot of people on their own.
How are you or do you plan to cope with inflation in retirement? Have you hedged your bet?
Suppose you were going to retire and among your investments you had $190k in some kind of tax deferred account. You could purchase an annuity without inflation protection and get something around $700/mo on a joint and survivor annuity. Over the next 16 years you would collect a total of around $135,000. With a 2% inflation rider your initial payment would be less, but your total collected might be more.
Alternatively, you could do what we did when my spouse inherited the same amount of money in 2007. She left it in the IRA and began withdrawals in 2008 on a 23.5 year life expectancy. These funds were invested 80% in US stock index funds, and the balance in US bond index funds. In the first year she received $8119. Over the rest of the time since then she has collected over $200,000. She still has 8.4 years of life expectancy left on the IRS table. The current balance in the account is over $209,000. Every year her withdrawals have increased now to the mid-$20k range. The return from this account has crushed inflation.
To deal with inflation, you need some funds invested in the stock market earning market average returns. You have to have faith in the US economy. You don’t need all your funds in the market, just some….you cannot beat inflation without accepting some risk….
And you have to hope you don’t run into an extended bear market or some international crisis. It works when it works as long as you are good with the risk which you seem to be. 👍
I started my career in the early 1970s. My first mortgage had a double-digit interest rate, I can’t remember the exact figure. I was well aware of the effects of inflation and took it into account when I stopped working full time in 2000 at age 51. Because of some semi-lucky investments, I had over $1,000,000 at the time and a lifestyle where I didn’t spend much.
I worked a part time job for 20 years after that, much longer than any of my “real” jobs. I invested mostly in stock index funds. I started Social Security at my FRA of 66.
I’ve always assumed that my investments would earn 0% when adjusted for inflation, the reality has been much better than that. I’m 75 now and, despite depending on my investments for about half of my income, their value now, adjusted for inflation, is close to the same as it was in 2000 when I stopped working full time.
This isn’t only a problem for retirees. When inflation heated up during the summer of covid, I got a bonus for working on site through 2020, an out of guidelines raise the next year, and everybody with a decent annual evaluation got a 3% raise next. All these pay increases were less than the rate of inflation. Even generous employers did not pay more to keep up with inflation.
The best hedge is to have a lot more money than you need.
In my pre-retirement seminars, back in the 80’s and 90’s, I referred to inflation as Rule of 72, “in reverse”.
Rule of 72: Take the annual interest rate, divide into 72, and you get the number of years it takes for money to double (for example: 6(%) into 72 = 12 years, assuming earnings are tax deferred).
Rule of 72 “in reverse”: Now take the inflation rate, divide into 72, and you get the number of years for your purchasing power to be halved (for example: 3(%) into 72 = 24).
So, assuming retirement at age 65, without an increase in the nominal amount, a 3% annual inflation rate will halve the purchasing power by age 90.
That said, inflation ≠ CPI. The CPI is someone else’s market basket of goods. You are a practicing economist – in terms of how you deal with price inflation – every time you go to buy something. At the grocery store, if beef is too expensive, you buy chicken or pork, or go meatless. These decisions are made almost unconsciously (except for the griping about ever increasing costs), at the snap of your fingers, one decision after another.
So, your household market basket of goods is changing all the time – with exceptions for housing, and a few other essentials where demand is inelastic or difficult to quickly adjust. The only way to confirm what inflation you actually suffered is look back on what you spent, and how your market basket of goods changed.
Reverse investment compounding. I’ve never read inflation referred to as that. Makes intuitive sense. I’ll add only to combat it, the majority of my investments are in stocks, TIPS, and I-Bonds.
I made it up. 😎
Hopefully, stocks will beat inflation in the long term (for spending more than10 years out). For the short term (the next 10 years) I have TIPS to counter inflation. Of course, with Armageddon possibly around the corner – hostilities between two nuclear-armed powers (Iran and Israel), the question may be moot.
Gee, how do you spell pensione? Isn’t that a place you stay on vacation in Italy?
Just an observation from one who knew his entire working life that, just like Dad, he wasn’t going to get a pension. Knowing you will get one can make you weak from a retirement savings/investment point of view. You are leaning/counting/depending on that pension for your retirement funding (along with SS). When you know you won’t get one, you know it is up to you to have enough to deal with things like inflation, big medical expenses, long-term care and/or anything else that might come along. So, you plan, save, and invest. And if you are fortunate (lucky) you can even retire early, live the good life in retirement, pay for grandchildren to go to college, and still watch your pile grow. Once you have enough so that your withdrawals are always less than 2% (along with SS), you have reached the comfort zone. COLAs are not material. Your total investments are enough.
Logical, yes. Reality, no. It just doesn’t happen that way.
Just a macro observation on the foregoing. There seems to be an acceptance that COLA adjustments to pensions are unaffordable at a corporate level yet a suggestion that individuals can fix this by buying annuities with COLA. Why should they be anymore affordable to individuals than corporates?
Sometimes simple just isn:t simple.
I think you are mixing things. Buying an annuity to create and income stream is one thing. Adding a COLA adds cost to that and generally is limited to about 2% and hardly fixes the problem.
Buying the annuity is a one time extra cost in terms of the promised benefit. The insurer takes the risk.
An employer with a COLA plan sees it costs compound over the years and adds funding obligations immediately. Especially costly if there is a high or no cap on the adjustments. Look at the comments here about NJ and the COLAs role in funding.
Pretty sure I’m not mixing things. Articulating sub optimally possibly. But as the topic is inflation my hypothesis is that it’s no easier to handle through annuities than pensions i.e. the insurer demands the same premium for the COLA risk. But it is easier to handle through investment portfolio although with the price being uncertainty/ volatility.
“A few of my fellow retirees still hold out the hope our former employer will give a COLA”
Still pissed off finding out the COLA on my pension is limited to 3% a year.
As an old benefits person, I note the words “finding out” didn’t you read your benefits book from day one?😎
My take is:
Not All Inflation is Equal for Retirees
The good news is that retirees often benefit from a more stable housing situation. If you own your home and have paid off the mortgage, shelter costs – a significant portion of the Consumer Price Index (CPI) – become less susceptible to inflation.
While transportation and food prices can fluctuate, retirees may drive less and potentially adjust food budgets. This could mean experiencing a lower overall inflation rate than the national average.
Planning Strategies for a Secure Retirement
Here are some key strategies to consider when planning for retirement and inflation:
The Takeaway
By focusing on debt reduction, building a healthy nest egg, and planning for potentially lower essential spending, retirees can navigate inflation more effectively. Remember, the key is proactive planning for a secure and comfortable retirement.
Source:
This is a good list but I think the nest egg point misses that if the point is to resist inflation, at least part of the nest egg needs to be in stocks. Just saving isn’t going to cut it unless it’s a whole lot of savings.
Hard to beat paying off the mortgage for peace of mind. But if one has a large, fixed-rate mortgage (so no housing inflation worries) and the cash to pay it off, actually using the cash to do so is not necessarily the best financial move. There is also peace of mind holding that cash (especially recently, with savings rates 200 to 300 basis points above the mortgage). One might also take more risk by putting some of the cash into equities. In my situation, right now online calculators advise keeping the mortgage (a 30-50k advantage over time). So, one can factor opportunity cost into the equation. All of this assumes looking at one’s total financial picture and having adequate resources to deal with all known expenses going forward.
Paying off my mortgage when I retired early at 53 was certainly a help. However, now I’ve moved to a Continuing Care Retirement Community my housing costs will increase each year, probably in line with inflation, as the CCRC’s costs, especially for salaries, will increase. On the plus side the CCRC is a non-profit, so no property taxes, and the fees include cleaning and all maintenance.
You write, “While transportation and food prices can fluctuate, retirees may drive less and potentially adjust food budgets. This could mean experiencing a lower overall inflation rate than the national average.”
I read a recent article (in Morningstar I think) on a study that showed that retirees spending tends to increase 1% lower than the inflation rate annually. One reason is that so many retirees have paid off their mortgage so housing inflation is not as big of an issue.
This would confirm what you write.
Recently, home insurance rates have soared. Maybe you are correct historically, but the last three years our homeowners insurance has increased far greater than anything else we pay for.
Yes homeowners insurance has increased significantly, but ours for an home in NH has increased $500/year in the past few years, but rents in total dollars I’m sure has increased significantly more in yearly dollar terms than $500 annually.
Yes, retirement inflation is different in some ways, but it still can hurt and needs to thought about.
From my point of view though
is not a way to deal with inflation. in fact cutting back on any part of a lifestyle should be the last resort. A good plan is to avoid that.
Agree. Especially lower essential expenses and even more especially reduced food costs.
Of course Quinny, but the point I was trying to make which I think you get is that one shouldn’t look at retirement spend in a vacuum and be afraid of the dooms day predictions. You sir are a fine example of that… That sweet 14 year Benz that just won’t part with… When car prices spiked during the pandemic, me thinks you said, OK, why do I need to get a new car? The prices have since leveled and off, guess what Quinny, you still have the Benz, You managed the inflationary environment of auto purchasing by deferring the purchase, you didn’t get bit by that bug.
best, Mike
Mike, you give me too much credit. I don’t think like that. Besides, your comment talked about essential spending like housing and food. I don’t think a new car is in the essentials category – certainly not my car.
I did not consciously defer a purchase.
The only reason I still have my 10 year old Mercedes is my irrational emotional attachment that I have written about before. Actually I’m trying to figure out how to get a new car and keep the old. I need a place to park it.
I get beaten up on HD frequently because of my simplistic views, my occasional discounting of expert advice and my tendency to fly by the seat of my pants.
However, working to age 67 with one company with a substantial pension, taking SS at FRA while still working and 60 years of saving, investing (not optimally no doubt) and being fortunate along the way, means I don’t worry about inflation.
What I really worry about everyday is the future for my children and grandchildren.
Richard, I am not beating you up over your simplistic views, for the occasionally discounting experts opinions, or your flying by the seat of your pants. I am actually patting you on the back. Even though we are slightly different in age and monetary status I have very similar tendencies and are usually in complete agreement with your views
Thank you
Interesting comments. One thing that we do that hasn’t been mentioned and is kind of “out of the box” thinking IMO, is how we stockpile everyday things like food, health and beauty aids, pet and household items, etc. As an example, today we were at the grocery and in the clearance area they had a whole bunch of the little cans of wet cat food for less than half price. We use this for our cat to put her medicine on daily, so we bought every can they had. We try to do this with anything we use regularly. We don’t overbuy so things spoil, but have been doing this a long time now so we have a good idea of how much we need. I would recommend trying this if you don’t do it already. It is a simple way to fight inflation. Chris
Richard. As for Teacher Pensions I can only speak for the NJ TPAF.
Unfortunately they don’t have COLA’s
Actually they do have a COLA, but it has been temporarily suspended until the pension trust is adequately funded. The ratio is not there yet.
While the Murphy Administration has kept its promises to fully-fund the pension, neither the Public Employees’ Retirement System (PERS) nor the Teachers’ Pension and Annuity Fund (TPAF) are projected to get to the target ratio necessary to reinstate the COLA soon. Chapter 78 states that the COLA for each of the state pension systems will be suspended until the funds reach a “targeted funded ratio” with regards to the plan’s funded status.
That’s because of years of fund mismanagement by politicians of every sort.
Thank you for the update/clarification. This is exactly why I like to visit HD. I am always learning something new and I especially enjoy your articles. I’m not there yet but I am partial to slightly grumpy wise old men. Your insights and experiences are much appreciated.
🙂
Dick, wasn’t the COLA’s “temporarily suspended” in 2011, and they still haven’t been restored Doesn’t sound very “temporary” to me, especially since it’s only 54% funded. The New Jersey Pension Fund is significantly underfunded even as the state increases payments to support it | Pensions & Investments (pionline.com).
I sat on two Governor task forces to evaluate pensions and benefits in NJ many yeas ago. One was chaired by Murphy. If what was done with NJ pensions over many years was in the private sector the plans would have been shut down and probably someone would be in jail. The fault of greedy unions and willing to please for votes politicians.
It will take years, full annual funding and a roaring stock market to get back to reunited funding levels.
The law outlines the requirements for reinstate COLAs which were one of the items that were not affordable or funded in the first place.
Once the plans are properly funded will the COLA be retroactive?
Not sure, but I doubt it. That would probably bust the funding ratio again.
Being young adults in the ’70’s, my wife and I have always invested as if inflation would return. Low debt levels, gold, silver and oil stocks, lots of cash. Other stocks we’ve bought were undervalued (in our opinion) and paid nice dividends. Rarely sold – have mutual funds and stocks we’ve owned for 35-40 years. Some we get more in yearly dividends than we originally paid for the stock. We’re much better off than most of our peers and have no fears of inflation.
Are you paying some hefty expense ratios on those old mutual funds?
Once I realized that my US pension would not have a COLA I started saving and investing. I was able to take early retirement, and leave the investments to grow, because I did have a pension, and retiree medical. I am finally spending from my portfolio this year, at 77, after moving to a Continuing Care Retirement Community. Before committing to the community I had a fee-for-service financial planner run the numbers for me at varying inflation rates. At a consistent 5% rate I would need to move to a smaller apartment but otherwise I should be OK.
Looks like I will spend 1% of my portfolio this year, but could be less depending on my taxes. Last year, the medical deduction for part of my entry fee meant I paid no income taxes.
For us earned income until age 70 was the plan. This eliminated the possibility of an insanely long retirement. At age 72 social security covers everything with change left over at the end of the month. Inflation and/or one of us dying will eventually necessitate a little help from the IRA. I suspect that it will be several more years before distributions are needed. In the meantime our IRA’s continue to grow.
Recently I overheard some ladies at the pool bemoaning their husband’s lousy teacher pensions. They retired in their early 50’s. Now in their late 70’s money has become tight. I wonder how much larger those pensions would have been with an additional 10 years’ worth of credits.
When you say SS covers everything, what is included in everything? Much discretionary spending?
Our property taxes and HOA fees are more than half our net SS checks after all deductions, including for taxes.
Agree and our utility bill takes another third.
Yes, I do mean everything Dick, and we live very very well. SS pays us about 75k. Keep in mind that NW Ohio is a low cost place to live. Property tax is our largest outlay at about 6.5k/year, and our HOA is only $160/ month. All our stuff is paid for. Having said that, if we were to take a Quinn like vacation we would need to hit the savings.
And most teacher pensions have COLAs too.
Knowing that our savings was all we were going to have in retirement, aside from all-important Social Security, it was scary to learn how inflation would take an ax to that nest egg over 30 years. I wrote on Humble Dollar a few weeks ago in Laying Down a Floor about my plan to cope with the inflation scourge in retirement. We’ll see how the plan pans out, but it’s already giving me peace of mind.
What is the inflation measure used in the TIPS? I don’t know how they work, is your money locked up for a certain period of years?
Hi Dick,
To answer your two questions:
The Consumer Price Index (CPI) is the inflation measure used in Treasury Inflation-Protected Securities (TIPS). In comparison, the Social Security annual Cost of Living Adjustment (COLA) is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI measures price changes for all urban consumers, while the CPI-W measures price changes for urban wage earners and clerical workers. Neither index sounds to me like they are that pertinent to retirees, but that’s what the government uses. ¯\_(ツ)_/¯
As for “Is the money locked up?”: I purchased and keep the bonds in our IRAs in our Vanguard accounts and can sell them on the secondary bond market (via VG) at any time. So it’s not like an insurance annuity where the money is locked away out of our reach. EXCEPT, as with all ladders, the plan is to hold each rung to maturity, whereupon each year a rung matures, I would get the guaranteed amount of the inflation-adjusted principal on those TIPS and interest from the other future rungs.
My TIPS ladder gives me certainty that a portion of my savings will keep pace with general inflation over time, which is what I was looking for. There is a lot more I could say, but for those curious about a TIPS ladder, read my article with more details (and good HD comments!) at https://humbledollar.com/2024/09/laying-down-a-floor/ and these helpful articles at https://www.tipsladder.com/resources/TipsLadderResources.html
I was struggling a bit with what a TIPS ladder is, and how to set one up, and found this Rob Berger video on YouTube to be extremely helpful: https://youtu.be/WMSOdk9Ga_Q?si=3rKtzmKm1P-KAIUo
I had thought I’d be doing an annuity ladder, but a TIPS ladder sounds better to me for inflation protection.
I understand the appeal of a TIPS ladder over an immediate fixed annuity that pays lifetime income. But you are giving up something important: longevity insurance. You can outlive a TIPS ladder.
In my case, I have money outside the TIPS ladder that will grow (hopefully) for the next 20 years (length of my ladder) and then, or before then, may use that money to buy an immediate fixed annuity for simplicity and longevity reasons. (Do they sell annuities to people in their 80s?)
Immediateannuities dot com provides annuity estimates up to age 90.
I did use your links to read about them. I just can’t see the more average retiree dealing with that approach. Not knocking it, just too complicated for most people, including me.
Setting up a TIPS ladder is a perfect task for a fee only financial advisor. Once it is set up you just spend the interest from the TIPS and the principal from the maturing bonds.
The Bureau of Statistics (BLS) calculates a research price index called the Consumer Price Index for Americans 62 years of age and older, or R-CPI-E. The R-CPI-E is used by those interested in measures of price change specifically based on the spending patterns of the elderly.
Why this statistic (which factors in a higher weighting for health care costs which affect the elderly more than the general public) is not used by the US government for inflation adjustments is anyone’s guess.
There are some years where the CPI- E is lower than the CPI-W and many years where the difference is a tenth of a percent or so,
Consumer Price Index for All Urban Consumers (CPI-U) is used to adjust TIPS value. A TIPS is just like any other Treasury bond. You can sell it at any time in the secondary market. But just like any bond if you sell it prior to maturity, you are subject to interest rate risk.
Yes, but in actual annual dollars I believe than rents have increased more than insurance. At least in my case I don’t believe my house insurance over the eight years we have lived in our newly built house in NH has increased more than $500.
I think you’ve answered your own question. You either work until you’ve built a non indexing pension that is more than adequate for your early years or you save in other vehicles like a 401k and rely on your investments beating inflation.
Except few people have a pension
So you save in DC pension and other vehicles and accept the responsibility of managing and withdrawing from your portfolio appropriately.
It feels like you want the answer to be buy an index linked annuity, which is of course an option for those afraid of managing their own affairs but it’s probably going to deliver less income than accepting some risk.
The thing is most Americans are not only afraid to manage their own money, they can’t and don’t very well. The strategies expressed on HD are fine, but not the real world for the less sophisticated savers and retires.
Yes, an immediate annuity with modest COLA, perhaps investment refund and J&S with a portion of savings is a good idea for many Americans. IMO
Maybe a good option given your punitive cost of healthcare meaning it’s broadly against people’s interests to retire pre qualification for Medicare.
But given you say most Americans are less sophisticated ( or maybe plain bad) at saving, where are the funds going to come from to buy the size of gold plated annuities you suggest? Which returns us to work into your 70s scenarios.
If your concern is for the average Joe you have to be very aware that they are nowhere near the comfort level you regard as essential by virtue of your relatively high level corporate career.
Dick, did your company ever communicate the tie between the lack of ad hoc pension increases and the 401(k) match? My previous company followed the same path as yours once 401(k) matches took hold, but I never saw any communication explaining the reasoning. Perhaps that’s because no one is entitled to any increase at all based on the pension summary plan details. Still, I appreciate your explanation that “in effect, a COLA was paid by the company in advance.”
Yes, quite extensively Ken. I was in charge of both plans and communications and I wanted to be sure people understood. We did give a COLA after the 401k, but only to people who retired before it had been in effect ten years. Needless to say, that way of corporate thinking is long gone.
My recent reading stated that the cumulative increase in the cost of living since COVID is 20%.
From January 2020 to August 2024 the seasonally adjusted CPI-U has increased 21.3%. That works out to an annual rate of 4.2% for that 56-month time period.
Just compounding at 3% for five years is 16%